The ECB And The Euro

A Look at the Consensus

 About two weeks ago, Bloomberg reported that “The stars are finally aligning for euro bears” – obviously, there was no such alignment in evidence hitherto. Although slightly dated, the article reflects the prevailing consensus. As we have prviously discussed in these pages, it is mainly a dollar-bullish consensus (83% dollar bulls in Merrill’s July 2013 fund manager survey, a level high enough to indicate that a major trend in the opposite direction may get underway). Since the euro is by far the biggest weight in the dollar index, it is by inference a bearish consensus on the euro.

“Firms from Morgan Stanley to Bank of America Corp. that for almost a year called for weakness in the 18-nation currency, only to see it soar to the highest level since 2011, say they’re about to be vindicated.

Fresh evidence of lower demand for the region’s bonds, combined with a potential European Central Bank interest-rate cut in as soon as two weeks, are only serving to push the euro lower, they say. Looming European Parliament elections that may expose rifts over government austerity measures are also seen weighing on the currency.

“The change has finally started to take place,” Ian Stannard, head of European currency strategy at Morgan Stanley in London, said in a May 19 phone interview. “When we see easing measures, it’s not just the initial impact of a potential rate cut, it’s going to be the asset market performance to those easing measures which will be the key to the euro.”

Morgan Stanley predicts the common currency will tumble 12 percent to $1.20 by September 2015 from $1.3669 at 7:52 a.m. in New York. Bank of America sees it dropping to its 2013 low of $1.2746. The median estimate of about 90 economists and analysts is for the euro to end the year at $1.32.

The bears have reason to be optimistic. 

[…]

Nader Naeimi, who helps oversee more than A$30 billion ($27.8 billion) at AMP Capital Investors Ltd., said May 20 from Sydney that in the last two months he boosted his positions in trades that would profit from a lower euro. Selling the currency is “one of the highest-conviction positions,” he said.”

The article continues along these lines – several more fund managers and bank analysts are quoted, and they are all of one mind. The euro will go lower. This time for sure.

New UBS chairman and former BuBa president Axel Weber has also chimed in, via a recent editorial in the FT. Although the euro’s exchange rate is only a side topic of his missive (his main concern is that financial market volatility is going to increase as a result of ‘QE tapering’ by the Fed), he stresses the divergent course of ECB and Fed policy in the context of the euro:

“Before long, these divergent fortunes are bound to lead to large differences in policy. In the US, interest rates could begin to rise in 2015. In Europe, they are likely to stay low for much longer. One might expect that movements in financial markets would reflect these expectations. However, so far, by and large, they have not. The dollar has been ailing for months, defying analysts’ expectations that the currency would strengthen in anticipation of higher US interest rates. What is going on?

The answer is that market expectations seem to count less than current conditions, which still support the euro. First, the high yields on government debt in countries such as Italy and Spain have made them an attractive investment for believers in the ECB’s pledge to do “whatever it takes” to save the euro. Second, America’s shrinking pension deficits may have stoked appetite among pension-fund managers to lock in profits and match liabilities, helping suppress long-term bond yields. And then there are the central banks. The Eurosystem’s balance sheet has been shrinking for more than a year, as banks that borrowed from the central bank under the longer-term refinancing operation (LTRO) have repaid their debts early. Meanwhile, the Fed’s balance sheet is still growing, albeit at a reduced rate.

However, these factors are temporary. LTRO repayments are coming to an end, US quantitative easing will be completed by the end of the year, five-year government bond yields in Spain are already similar to those in America and long-dated US government bond yields are pricing in unrealistically low expectations of future economic growth. Diverging monetary policy will soon begin to have more impact.”